The concept of a level playing field tends to resonate with most Americans. In the field of trade, China, Canada, Mexico, Japan and Germany are the U.S.’s top trading partners. America runs a trade deficit with each of these countries, but the deficit with China is particularly large: $375 billion in 2017, which accounts for 2/3rds of the entire U.S. trade deficit with all countries. And the size of the gap has been growing ever since China entered the World Trade Organization at the end of 2001. Chinese subsidies to local companies and intellectual property rights issues may have accelerated this imbalance. So perhaps some leveling is in order.
The Trump administration has chosen a high-stakes approach, using the threat of tariffs to force change. While an outcome ultimately could be beneficial to U.S. companies, individual investors are currently hanging in the balance. The financial markets, and in particular U.S. equities prices, have been very responsive lately to pronouncements from both U.S. and Chinese officials.
The bottom line from our perspective as investment managers is that tariffs, if they are enacted, will likely cause problems for the financial markets. Strategists at GMO in Boston recently published a paper entitled ‘Trade Wars are Bad, and Nobody Wins’. The crux of the issue is a potential increase in inflation. Widespread tariffs would mean large price rises. This may force the Federal Reserve’s hand, pushing interest rates up at a quicker pace. Unexpected inflation + higher rates + greater economic uncertainty = challenges for risky assets.
Rob Kania is Principal and Co-Founder of Laurentide Advisory